Chapter 7 Profit Maximization and Perfect Competition Slide 1Chapter 7

Slide 2 Choosing Output in the Long Run In the long run, a firm can change all its inputs, including the size of the plant. We assume free entry and free exit.

Chapter 7Slide 3 q1q1 A B C D In the short run, the firm is faced with fixed inputs. P = $40 > ATC. Profit is equal to ABCD. Output Choice in the Long Run Price ($ per unit of output) Output P = MR $40 SAC SMC In the long run, the plant size will be increased and output increased to q 3. Long-run profit, EFGD > short run profit ABCD. q3q3 q2q2 G F $30 LAC E LMC

Chapter 7Slide 4 q1q1 A B C D Output Choice in the Long Run Price ($ per unit of output) Output P = MR $40 SAC SMC Question: Is the producer making a profit after increased output lowers the price to $30? q3q3 q2q2 G F $30 LAC E LMC

Chapter 7Slide 5 Choosing Output in the Long Run Accounting Profit & Economic Profit Accounting profit = R - wL Economic profit = R - wL - rK  wl = labor cost  rk = cost of capital

Chapter 7Slide 6 Choosing Output in the Long Run Zero-Profit If R > wL + rk, economic profits are positive If R = wL + rk, zero economic profits, but the firms is earning a normal rate of return; indicating the industry is competitive If R < wl + rk, consider going out of business Long-Run Competitive Equilibrium

Chapter 7Slide 7 Choosing Output in the Long Run Entry and Exit The long-run response to short-run profits is to increase output and profits. Profits will attract other producers. More producers increase industry supply which lowers the market price. Long-Run Competitive Equilibrium

S1S1 Output $ per unit of output $ per unit of output $40 LAC LMC D S2S2 P1P1 Q1Q1 q2q2 FirmIndustry $30 Q2Q2 P2P2 Profit attracts firms Supply increases until profit = 0 Slide 8Chapter 7

Slide 9 Choosing Output in the Long Run Long-Run Competitive Equilibrium 1) MC = MR 2)P = LAC  No incentive to leave or enter  Profit = 0 3) Equilibrium Market Price

Chapter 7Slide 10 Choosing Output in the Long Run Economic Rent Economic rent is the difference between what firms are willing to pay for an input and minimum amount necessary to obtain it.

Producer Surplus Producer surplus measures the difference between the market price that a producer receives and the marginal cost of production. Chapter 7Slide 11

Chapter 7Slide 12 Firms Earn Zero Profit in Long-Run Equilibrium Ticket Price Season Tickets Sales (millions) LAC $7 1.0 A baseball team in a moderate-sized city sells enough tickets so that price is equal to marginal and average cost (profit = 0). LMC

Chapter 7Slide $10 Economic Rent Ticket Price $7 LAC A team with the same cost in a larger city sells tickets for $10. Firms Earn Zero Profit in Long-Run Equilibrium Season Tickets Sales (millions) LMC